What Is Bail-in?

In 2016, Parliament introduced an amendment to the Canada Deposit Insurance Corporation (CDIC) Act to add the “bail-in power” to the Corporation’s resolution tools. This tool is only for use in respect of Canada’s six largest banks, known as Domestic Systemically Important Banks (D-SIBs). A domestic systemically important bank (D-SIB) is a bank that could broadly impact the domestic economy should it fail.

The bail-in power is a tool that CDIC can use to recapitalize a domestic systemically important bank (D-SIB) that is failing or is about to fail by converting certain debt1 into common shares. In Canada, the Office of the Superintendent of Financial Institutions (OSFI) has designated Canada’s six largest banks as systemically important2.

In contrast to taxpayer-funded bail-outs, which were used in other jurisdictions to recapitalize banks during the 2008 global financial crisis, a “bail-in” ensures that losses are imposed on certain creditors and shareholders by having their debt converted into common shares.

In a bail-in, CDIC would take control of the D-SIB and recapitalize it by converting bail-in debt into equity, while ensuring that the D-SIB remains open and continues to provide critical services to its customers. This would preserve financial stability, minimize disruptions to the financial system, reduce taxpayer exposure and reduce incentives for D-SIBs and their shareholders to take excessive risk (see Objectives).

What Is Included?

In Canada, the bail-in power only applies to debt that has specific features.

These include:

  • Long-term (i.e., original term to maturity of more than 400 days) unsecured senior debt that is tradable and transferable; and
  • Any preferred shares and subordinated debt that are not Non-Viability Contingent Capital (NVCC).3

Only instruments that are issued4 by D-SIBs on or after September 23, 2018 will be eligible for a bail-in conversion (i.e., the regime does not apply retroactively to instruments issued prior to that date).

What Is Excluded?

Deposits, including chequing accounts, savings accounts and term deposits such as GICs, are not subject to the bail-in power. In addition, secured liabilities (e.g., covered bonds), eligible financial contracts (e.g., derivatives) and most structured notes are excluded from the bail-in power.

See more about what is included and excluded.

Total Loss Absorbing Capacity (TLAC)

In order for the bail-in regime to be credible and for a bail-in conversion to be successful, D-SIBs need to have a sufficient amount of regulatory capital and bail-in debt that can be used to absorb losses and to recapitalize the failing D-SIB (see OSFI’s TLAC guidance or this bail-in example).

In Canada, D-SIBs will be required to hold an amount of regulatory capital and bail-in debt (at least equal to 21.5% of their risk-weighted assets, which has been specified by the Superintendent of Financial Institutions pursuant to orders issued to each D-SIB. This requirement will be monitored and enforced by the Superintendent of Financial Institutions (see D-SIB designation and TLAC).5

This requirement is broadly consistent with the Financial Stability Board (FSB) TLAC standard.6

How Would the Bail-In Power Be Used?

CDIC has a number of tools to manage the potential failure of a member institution. The bail-in power is one of the tools available to CDIC to resolve a failing D-SIB.

The process by which CDIC obtains its authority to use the bail-in power is the same as for most of CDIC’s other resolution tools.

The bail-in power cannot be used unless CDIC has taken temporary control or ownership of the D-SIB (see Resolution Stages). This is important, as a bail-in conversion would be part of a suite of measures to address the underlying causes of failure and to return the D-SIB to viability. Other measures could include, for example, replacing the directors of the D-SIB where appropriate, using the D-SIB’s existing employees and contractors to ensure the essential services of the D-SIB are maintained, and restructuring the D-SIB as necessary – for example, selling off troubled assets or subsidiaries.

While in control, CDIC would determine: (1) how much bail-in debt to convert to absorb any losses and ensure that the D-SIB is adequately recapitalized; and (2) the number of common shares bail-in debtholders would receive upon the conversion of their claims (see Bail-in Power).

After the completion of the bail-in conversion and other necessary restructuring measures, CDIC would return the D-SIB to private sector control.


Footnotes:

  1. For simplicity, the reference to “bail-in debt” in this document includes any preferred share that is subject to the bail-in power by virtue of not being non-viability contingent capital (see What is Included?).
  2. Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, National Bank of Canada, Royal Bank of Canada, and the Toronto-Dominion Bank.
  3. Since January 1, 2013, OSFI has required all non-common regulatory capital instruments (for example, subordinated debt and preferred shares) issued by banks to contain contractual terms (NVCC) that allow for the automatic conversion into common shares (or write down of the instrument) if the bank becomes non-viable
  4. Or amended to increase their principal value or extend their term to maturity.
  5. TLAC comprises more than bail-in debt. It generally consists of: Tier 1 capital (Common Equity Tier 1 capital and Additional Tier 1 capital); Tier 2 capital; and bail-in debt.
  6. TLAC, or Total Loss Absorbing Capacity, is a standard applicable to global systemically important banks. This standard was finalized by the Financial Stability Board in late 2015 and endorsed by the G20.